Chapter Eight

International Financial Reporting: Ethics and Corporate Governance Considerations

1
McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Difficulties of Rules vs. Principles-Based Approaches

Rules-based:
Often provide users a way of avoiding the intended rules

Principle-based:
Enforcement difficulties arise since little guidance exists

SEC recommends standards following the principles-based approach with the following characteristics:
Based on improved and consistently applied conceptual framework Clearly state the accounting objective of the standard Provide sufficient detail and structure Minimize exceptions Avoid use of bright-line test

Objectives-Oriented Standards
SEC's favored approach Greater responsibility for managers and auditors
8-2

SEC Roadmap for Adoption of IFRS

In US:
2014- Large accelerated filers 2016- non-accelerated filers SEC permits foreign companies to use IFRS w/out reconciliation to GAAP Final decision by SEC to mandate IFRS will be based on the quality and comprehensiveness of accounting standards included

Global Adoption of IFRS

117 countries have signed up to adopt IFRS Movement towards convergence began October 2002 IASB Framework for the Preparation and Presentation of Financial Statements Serves as guide to resolving accounting issues

8-3

Rule vs. Principles-Based Standards

Rules-Based
Describe what to do

Principles-Based
Describe how to decide what to do Requires judgment at transaction and financial statement level Simpler Easier to defend professional judgment and principles-based standards if challenged in stockholder lawsuits Concerns:
Economic substance over form might lead to managed earnings Greater difficulty in seeking remedies

IASB Framework for the Preparation and Presentation of Financial Statements

Serves as guide to resolving accounting issues
8-4

Examples of Rules Based VS. Principles Based Standards

Accounting for Leases
Principles-based:
Emphasizing economic substance over legal form If substance of transaction is effectively to transfer ownership to the lessee, then it's capitalized Drawback: Could lead to a lack of comparability

Rules-based:
Form over substance If any 4 lease criteria are met, then must be capitalized Drawback: Relies on implementation guidance which can be manipulated

8-5

Examples of Rules Based VS. Principles Based Standards

Valuation and Recording of Property, Plant and Equipment

Principles-based
Generic and considerably ambiguous Drawback: lack of precise guidelines could create inconsistencies across organizations Fair value estimates Cost or revaluation method can be used Quantitative approach- application depends on the professional judgment of decision maker

Rules-based
Bright-line guidelines Reasonable person standard- very subjective and difficult to judge
8-6

Distinction between Provisions and Reserves

Provisions- liabilities recognized by charges against profit, decreases profit and net assets Reserves- element of shareholder's equity, reflects reduction of available profit and increase in corresponding equity account with no net effect on either Secret reserves or Hidden reserves Arise because a company: Failed to recognize an asset on balance sheet Deliberately measured an asset at unreasonably low value Set up unnecessary high provisions Motivation to report Conservatism Tax deductions Result Net assets and equity will be understated
8-7

Comparative Corporate Governance

Critical to monitor quality and robustness of conversion process A need for assurance that decisions are being made that are in the public's best interest Under IFRS 1: First-time Adoption of International Financial Reporting Standards
Any restatement is usually viewed as negative by investors and regulators Audit committees must assess this risk effectively There will likely be a challenge in meeting stakeholder expectations given the changed results
8-8

Corporate Governance in Germany

System mirrors many European countries Two-tier board of directors structure Extensive labor representation on the Supervisory Board Management Board- in charge of managing enterprise Supervisory Board- non-management members who appoint, supervise and advise members of Management Board on policy Establishes conduct and activities of both Boards Stresses need for transparency Clarifies shareholder rights comply-or-explain principle
8-9

Corporate Governance in China

State-owned enterprise (SOE) has been undergoing a process of corporatization Includes better defined shareholder rights Increased efficiency and accountability 3 statutory corporate governing bodies: Shareholders Board of directors Board of supervisors 2 new statutory corporate positions: Chair of the board of directors CEO

8-10

Corporate Governance in India

Various committees issue variety of recommended guidelines Kumar Mangalam Birla Committee- suggests separate section on corporate governance compliance in annual report Many similarities between India and US Lack of independent members of the board of directors Key challenge is to enforce corporate governance requirements and make recommended practices mandatory Tata Group Multinational conglomerate based in Mumbai, India Largest private corporate group in India

8-11

OECD Principles of Corporate Governance

International benchmark for policy makers, investors, corporations, and other stakeholders Provide basis for extensive program of cooperation between OECD and non-OECD countries Principles have been reviewed since accounting fraud in late 1990's and early 2000's Good corporate governance is important to broad and growing segments

8-12

Global Code of Ethics

International Ethics Standards Board for Accountants (IESBA)
Established by IFAC to develop and issue high quality ethical standards for professional accountants Issued Code of Ethics for Professional Accountants (IFAC Code)

Similarities between IFAC Code and AICPA Code of Professional Conduct:

1. 2. Act in accordance with public interest Identify threats to independence and develop safeguards to mitigate Independence in mind Independence in appearance Adhere to standards related to integrity, objectivity, professional competence and due care, confidentiality, and professional behavior

3. 4. 5.

8-13

Ethical Conflict Resolution

Both AICPA Code and IMA's Statement of Ethical Professional Practice: Obligate accountant to go through the chain of command up to the audit committee to resolve accounting differences IFAC Code Accountant should consider: Relevant facts, ethical issues involved, fundamental principles related to matter, established internal procedures, and alternative courses of action As well as weigh the consequences of each possible course of action
8-14

International Auditing Standards

International Auditing and Assurances Board (IAASB)
Established by IFAC Issue pronouncements that govern audit, review, and other assurance and related services engagements conducted in accordance with ISAs ISAs do not override local laws or regulations

Similarities between International auditing standards and US GAAS

1. Perform audit with attitude of professional skepticism 2. Obtain reasonable assurance that financial statements taken as whole are free from material misstatement
8-15

International Auditing Standards

Similarities between International auditing standards and US GAAS16
3.Audit risk risk that auditor expresses an inappropriate opinion 4.In planning and performing audit, auditor must consider the risks of material misstatements due to fraud 5.COSO Integrated Framework- obtain an understanding of the control environment 6.When considering materiality, auditor should consider intended users

8-16

Differences Between International Audit Report and U.S. Audit Report International Report
Reference to IFRS Management's responsibilities in respect to internal controls and material misstatement Selection of audit procedures requires exercise of professional judgment stated in scope paragraph Overall opinion to be couched in the words present fairly or a true and fair view in accordance with IFRS in opinion paragraph A separate paragraph provided for entities required by law to report on compliance with legal and regulatory requirements in
8-17

True and Fair View Versus Present Fairly

IFAC Code equates both terms US believes they convey different meaning and level of assurance to investors and creditors True and fair view override Criteria in US is conformity with GAAP Distinction may be blurred as we move towards IFRS

8-18